The acronyms NOPAT vs EBITDA are actually important business valuation methods, and the debate about them can lead you into the finer details of a company’s financials.
NOPAT (net operating profit after tax) is the amount of money a business makes from its day-to-day operations after taxes. Because analysts start with a company’s operating income, both cost of goods sold and operating expenses are important variables that contribute to the calculation of a company’s NOPAT.
EBITDA (earnings before interest, taxes, depreciation, and amortization) also zeroes in on a firm’s operational efficiency, but it so by adding interest expenses, tax payments, and depreciation/amortization expenses back to net income. By doing this, it removes the effects of certain variables that can cloud a company’s financial performance.
Read on for a closer look at EBITDA vs NOPAT, how these valuations are calculated, and how they compare.
What Is NOPAT?
NOPAT, which stands for Net Operating Profit After Tax, is a performance metric that tells you what a company’s income from operations would be if it had no debt (i.e., no interest expenses from small business loans or related tax write-offs).
By eliminating interest — and, thus, the impact of a company’s capital structure — NOPAT makes it easier to compare two companies in the same industry, even if one is much more highly leveraged than the other. NOPAT can also be used to compare a company’s performance from one year to the next.
NOPAT also doesn’t include one-time losses or charges, which can temporarily skew a company’s bottom line.
NOPAT is often considered one of the more realistic performance metrics because it includes many expenses that others don’t (most notably depreciation and amortization).
NOPAT Formula
NOPAT = Operating Income X (1 – Tax Rate)
To calculate NOPAT, operating income (also known as operating profit), must be determined. This is the amount of profit a company makes after the cost of goods sold (COGS) and operating expenses (OPEX) are taken into account.
To determine a company’s operating income, subtract operating expenses from gross profits:
Operating Income = Gross profits – Operating Expenses
The formula to calculate gross profit is:
Gross Profit = Revenue- Cost of Goods Sold
Here’s a further breakdown of each variable you’ll need:
• Revenue: Revenue is the total sales generated by services and/or the sale of goods. It is how much money a company brought in.
• Cost of Goods Sold (COGS): COGS is any direct costs associated with the selling of goods or services. Common expenses associated with COGS include:
◦ Factory labor
◦ Freight
◦ Parts used during manufacturing/ production
◦ Raw materials
◦ Storage
◦ Wholesale price of goods
• Operating expenses (OPEX): Any costs associated with the day-to-day running of a company. Common operating expenses include:
◦ Advertising
◦ Equipment
◦ Depreciation
◦ Insurance
◦ Inventory
◦ Maintenance
◦ Marketing
◦ Office supplies
◦ Payroll
◦ Property taxes
◦ Rent
◦ Repairs
◦ R&D
Recommended: Net Operating Income vs EBITDA
How Does NOPAT Work?
NOPAT measures a company’s financial performance without taking into consideration its capital structure — meaning if it were unleveraged and had no debt. By doing this, financial analysts can more easily compare two companies operating within the same industry.
To assess a business’s performance, analysts can look at a company’s sales (the “top line”), but sales alone do not give any insight into operating efficiency. A company can have great sales and still go out of business if it has high operating expenses or COGS.
You can go the opposite route and just look at the “bottom line,” or net income. This figure includes operating expenses. However, it also includes tax write-offs like interest on debt, which can cloud a company’s performance.
NOPAT is effectively somewhere in the middle. It doesn’t just look at sales, and it removes the influence of leverage to offer a more accurate picture of operating efficiency. Think of it as a hybrid of total sales and net income.
Calculating NOPAT
To calculate NOPAT, analysts and investors need access to a company’s income statement (because operating income is a direct line item on the income statement).
The effective tax rate is the percentage amount needed for taxes, so the remainder (1 – the effective tax rate) is the amount left after allowing for taxes. So, for example, if a company’s effective tax rate is 30%, the net operating profit after tax would be 70% of the company’s operating profit. (or 1 – .30).
What NOPAT Tells You
NOPAT shows you a firm’s after-tax profits from its day-to-day business operations. As a result, it tells you what a company’s profitability would be if it did not receive tax benefits from holding debt. It also highlights how well a company uses assets to generate profits for core operations.
Analysts use the NOPAT to compare business performance to past years, and to assess how a company is performing against its competitors.
What Is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It’s a metric often used by investors, analysts, and sometimes companies to measure a firm’s operational profitability because it excludes any effects caused by capital expenditure decisions (that result in non-cash charges like depreciation and amortization) and financing choices (which are reflected in interest payments).
A lender might also consider your EBITDA when you apply for a small business loan (along with your credit scores, revenues, and other metrics) to get a fuller picture of your company’s financial health.
To truly understand EBITDA, it helps to understand the mindset behind removing the expenses listed in its name. Here’s a closer look.
• Interest: This refers to interest paid on debt, including various types of small business loans. EBITDA doesn’t include this because how much debt a company will vary depending on a company’s financing structure. Some companies are more leveraged than others and, as a result, have widely different interest expenses. To better compare the relative performance of different companies, EBITDA adds interest paid on debt back to net income.
• Taxes: A company’s tax burden is based on its structure, total revenue, and location. Therefore, two companies with the same amount in sales could pay very different amounts in taxes.
• Depreciation: Depreciation allows a company to spread out the cost of a physical asset over the course of its useful life (minus any salvage value). While depreciation is a very real cost, it can vary significantly from one firm to the next, depending on the historical investments it has made. Since this does not reflect a company’s current operating performance, EBITDA leaves it out of the equation.
• Amortization: Similar to depreciation, amortization is the process of spreading out the cost of intangible assets, such as patents, copyrights, and trademarks, over their useful life. Some companies have more costs associated with intangible assets than others. Once again, the mindset is that regardless of what those costs are, it does not reflect a company’s operational efficiency.
In addition to EBITDA, there is also adjusted EBITDA, which removes non-recurring, irregular, and one-time items that may distort EBITDA. This can help level the playing field even more.
Recommended: Typical Small Business Loan Fees
NOPAT vs EBITDA Compared
So the question at this point is: NOPAT vs EBITDA, what is better? The answer depends on what you are looking for. Here’s a look at their similarities and differences.
Similarities
• Both EBITDA and NOPAT are used to calculate the financial strength of a company.
• Interest from loans is not considered for both EBITDA and NOPAT.
• Both place value on a company’s profits from its core areas of business.
Differences
• NOPAT is after taxes, whereas EBITDA is prior to tax payments.
• EBITDA also includes other non-operating income.
• NOPAT accounts for depreciation and amortization charges, while EBITDA adds them back.
Here’s a side-by-side comparison of EBITDA vs NOPAT:
| EBITDA | NOPAT | |
|---|---|---|
| Is a performance metric used by analysts and investors | ✓ | ✓ |
| Includes more expenses | X | ✓ |
| Accounts for depreciation and amortization expenses | X | ✓ |
| The effect of interest on debt is removed | ✓ | ✓ |
| Begins with net income | ✓ | X |
| Begins with operating income | X | ✓ |
Pros and Cons of Using NOPAT
Here are the advantages and disadvantages of using NOPAT in chart form:
| Pros of Using NOPAT | Cons of Using NOPAT |
|---|---|
| Gives analysts a way to compare the financial performance of two companies with different levels of debt | Is not a true calculation of a company’s profitability |
| Can be used to buy equipment, including vehicles | Can be used for any business-related expense |
| Includes depreciation and amortization, which are very real expenses for companies | More useful to analysts and investors than business owners |
| Acts as a starting point for the calculation of free cash flow to the firm | Shows profitability as a monetary value, making it less useful for comparing companies of different sizes |
NOPAT vs Unlevered Free Cash Flow
Unlevered free cash flow (also known as free cash flow or UFCF) is a theoretical cash flow figure for a business. It measures how much cash a company would have after all operating expenses, capital expenditures, and investments in working capital have been made.
The formula for UFCF actually can use NOPAT or EBITDA:
NOPAT − Net Investment in Operating Capital = Free Cash Flow
OR
EBITDA – Capital Expenditures – Working Capital – Taxes = Free Cash Flow
Capital expenditures typically include any investments a company has made in tangible assets like machinery, buildings, or any type of heavy equipment.
Working capital, on the other hand, includes such items as the cost of inventory, accounts payable, and accounts receivable.
NOPAT, by contrast, does not take into account changes in net working capital accounts (such as accounts receivable, accounts payable, and inventory). As a result, a company’s NOPAT will be different from its unlevered free cash flow.
Example of NOPAT
Cheryl’s Chocolate, a fictional high-end chocolate store, had a total revenue of $800,000 the previous year. Its COGS was $250,000, and it spent $150,000 in operating expenses. It had an operating income of $400,000 ($800,000 – $250,000 – $150,000 = $400,000).
Cheryl’s Chocolate has a tax rate of 30%.
To calculate its NOPAT:
Operating income X (1- tax rate)
$400,000 X (1- 0.3)
$400,000 X (0.7)
NOPAT= $280,000
The Takeaway
Both EBITDA and NOPAT are useful performance metrics. NOPAT represents a company’s operating income after taxes and doesn’t account for interest expenses. EBITDA also shows a business’s earnings before interest, but further adds back non-cash charges like depreciation and amortization.
Both NOPAT and EBITDA can be used to track a company’s performance year over year as well as compare companies within the same industry. Some analysts prefer NOPAT to EBITDA because it includes more expenses.
Understanding these corporate metrics can be valuable as you work and make key decisions about expenses and funding, such as business loans.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How can you convert EBITDA to NOPAT?
You would first convert EBITDA (earnings before interest, taxes, depreciation, and amortization) into EBIT (earnings before interest and taxes) by backing out depreciation and amortization from the EBITDA number. Next, you would use this formula to calculate NOPAT (net operating profit after tax), using the formula NOPAT = EBIT X (1 – Tax rate).
Is NOPAT the same thing as net income?
No. Net income is calculated by deducting all the expenses incurred during the year from total revenue. NOPAT (net operating profit after tax), on the other hand, is calculated using just a company’s operating income, which is the amount of profit realized from a business’s operations.
What makes NOPAT a better performance measure than net income?
Unlike net income, NOPAT (net operating profit after tax) considers what a company’s income from operations would be if it had no debt or interest expense. As a result, it can be more useful than net income for comparing two companies in the same industry that may have different capital structures (such as one that is highly leveraged and one with no debt).
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